Does the Future of Community Banking Rest on Technology?

In Bank Director’s 2016 Technology Survey, the participants identified the following as the greatest business concerns in terms of the growth and profitability of their banks: regulatory compliance (59 percent), becoming more efficient (38 percent), competition from other banks (30 percent), regulations from the Consumer Financial Protection Bureau (28 percent), weak economic growth in their market (28 percent) and the ability to implement new technology (27 percent).

It’s hardly a surprise that regulatory compliance was the top concern of the 199 survey participants, a group that included bank CEOs, board chairs, independent directors, chief financial officers and senior technology executives. Fifty-eight percent of the respondents represent banks with $1 billion in assets or less, and this group has been disproportionately impacted by the significant increase in regulations that has occurred since the 2008 to 2009 financial crisis. In many respects, this is actually a money problem—hence the respondents’ concern about the impact of regulation on their profitability. While banks of all sizes have seen their compliance costs go up, small banks lack the scale or revenue base to absorb those higher costs as efficiently as large ones can.

Most of these issues are actually interrelated. The increased regulatory burden is one of several reasons why banks need to become more efficient, since this would help ease the pressure on their profitability from higher compliance costs. And one of the ways in which they will become more efficient will be through the implementation of new technology. For example, as banks place greater emphasis on digital distribution, in response to customer demand, they will be able to reduce the number of branches they have—which will lead to significant cost savings. Weak economic demand is one reason why banks worry about competition from other banks. Banking has become a zero sum game in the current economy, with everyone scratching and clawing to get what they can.

Another possible answer to this question was competition from nonbank entities, and only 22 percent of the respondents chose this as one of their top three concerns. However, when we asked later in the survey to identify the nonbank competitors that worried them the most, online marketplace lenders received the most votes, at 48 percent. And when we asked them how they felt about competition from these online lenders, 60 percent said they should be more highly regulated and 41 percent worried that these lenders could siphon off loans from their banks.

There is a definite theme that emerges from these questions. The survey participants are worried about the higher cost of regulation and its impact on the profitability of their banks. A majority of them also believe it’s unfair that banks are more heavily regulated than marketplace lenders, which are hardly regulated at all and yet compete with banks for business. Of course, banks are also experiencing lots of competition from other banks, as well as their old nemesis the credit unions. But the rise of marketplace lenders as a competitive threat is especially troublesome because it’s been enabled by advances in technology that banks are scrambling to keep pace with.

I am one who believes that marketplace lenders are here to stay. Individual companies will wax and wane, but the underlying dynamic that supports them—data driven loan underwriting technology—is growing in usage. And it’s beginning to go mainstream. Goldman Sachs, the gold-plated investment bank, has launched a marketplace lending operation called Marcus that will compete with the likes of Lending Club and SoFi for unsecured consumer loans. And JP Morgan Chase & Co., the country’s largest bank, has teamed up with On Deck Capital to target the small business loan market.

My sense is that most community banks under $1 billion in assets have yet to feel the full effects of competition from marketplace lenders because they are tightly focused on commercial real estate and C&I lending opportunities in their local markets, while marketplace lenders have focused mostly on unsecured personal and small business loans. But for how long? I’d be very surprised if data-driven underwriting technology doesn’t begin to find a place in the CRE and C&I loan markets as well because the efficiency advantages are too great to ignore.

There is some talk that marketplace lenders should be regulated just like the banks, and the Office of the Comptroller of the Currency has even raised the possibility of a federal charter for nonbank marketplace lenders. That might create more of a level playing field when it comes to the regulatory burden issue, but financial reform moves slowly in Washington, so I wouldn’t expect the feds to ride to the industry’s rescue anytime soon. I think community banks will have to solve this problem on their own, primarily through the implementation of new technology that will significantly improve their efficiency.

Only 27 percent of the survey respondents included technology as one of their three greatest business concerns, but it should have been at the top of the list.